Which risk type is specifically associated with a single company and can be mitigated by diversification?

Which risk type is specifically associated with a single company and can be mitigated by diversification?

• A. Company (Non-Systematic) Risk
• B. Market (Systematic) Risk
• C. Asset Allocation
• D. Diversification

Answer: (A)

This question tests how unsystematic versus systematic risk behave with diversification. Unsystematic (company-specific) risk is the risk tied to a single company—the chance that events like poor management decisions, product failures, or legal issues affect only that firm. Because these factors are idiosyncratic, spreading investments across many companies and sectors reduces the impact of any one company’s problems on the overall portfolio. That’s why this type of risk is the one that can be mitigated by diversification. In contrast, market (systematic) risk affects the entire market and cannot be eliminated just by holding more stocks. Asset allocation and diversification are strategies for managing risk, but only unsystematic risk is specifically mitigated through diversification.

This question tests how unsystematic versus systematic risk behave with diversification. Unsystematic (company-specific) risk is the risk tied to a single company—the chance that events like poor management decisions, product failures, or legal issues affect only that firm. Because these factors are idiosyncratic, spreading investments across many companies and sectors reduces the impact of any one company’s problems on the overall portfolio. That’s why this type of risk is the one that can be mitigated by diversification. In contrast, market (systematic) risk affects the entire market and cannot be eliminated just by holding more stocks. Asset allocation and diversification are strategies for managing risk, but only unsystematic risk is specifically mitigated through diversification.